Methodist Hosp. of Sacramento v. Shalala

Decision Date25 November 1994
Docket NumberNo. 93-5148,93-5148
Citation38 F.3d 1225
Parties, 63 USLW 2384, 46 Soc.Sec.Rep.Ser. 63, Medicare & Medicaid Guide P 42,911 METHODIST HOSPITAL OF SACRAMENTO, et al., Appellants, v. Donna E. SHALALA, Secretary of Health and Human Services, Appellee.
CourtU.S. Court of Appeals — District of Columbia Circuit

Cary M. Adams argued the cause and filed the briefs, Sacramento, CA, for appellants.

John P. Schnitker, Atty., U.S. Dept. of Justice, argued the cause, Washington, DC, for appellee. With him on the brief were Frank W. Hunger, Asst. Atty. Gen., Eric H. Holder, Jr., U.S. Atty., Anthony J. Steinmeyer, Atty., U.S. Dept. of Justice, Washington, DC, and Lawrence J. Harder, Baltimore, MD, and Gerard Keating, Counsel, U.S. Dept. of Health and Human Services, Washington, DC.

Before SILBERMAN, SENTELLE, and ROGERS, Circuit Judges.

Opinion for the Court filed by Circuit Judge ROGERS.

ROGERS, Circuit Judge:

This appeal challenges a policy that denies retroactive effect to a revised wage index used in determining Medicare reimbursement rates under the Prospective Payment System. In August 1984, the Secretary of Health and Human Services corrected an erroneous regional wage index for the Sacramento area, but refused to apply the new index retroactively to January 1984. Appellants, a group of eight non-profit hospitals affected by the erroneous index, unsuccessfully challenged this policy in the district court. On appeal, the hospitals contend that (1) the Medicare statute requires the Secretary to give retroactive effect to wage index corrections; (2) the Secretary's policy is arbitrary and capricious because it is inconsistent with the regulatory history and produces absurd results; and (3) the policy is invalid for lack of adequate notice and comment under the Administrative Procedures Act. Consistent with our deferential standard of review, we conclude that the Secretary's choice was permissible. We also conclude that the policy is not procedurally invalid. Accordingly, we affirm.


A. Statutory Framework. The Medicare program, established in 1965, provides federally funded health insurance for the elderly and disabled. See Title XVIII of the Social Security Act, 79 Stat. 291, as amended, 42 U.S.C. Sec. 1395 et seq. (1988). Under an extremely "complex statutory and regulatory regime," Good Samaritan Hospital v. Shalala, --- U.S. ----, ----, 113 S.Ct. 2151, 2154, 124 L.Ed.2d 368 (1993), health care providers are reimbursed for certain costs that they incur in treating Medicare beneficiaries. Prior to October 1983, Medicare reimbursements were based on the "reasonable costs" of inpatient services furnished to Medicare patients. 42 U.S.C. Sec. 1395f(b) (1988). Under this regime, providers were reimbursed for the actual costs that they incurred, provided they fell within certain cost limits. 1 Thus, as hospital costs increased, so too did Medicare reimbursements.

Concerned about escalating Medicare expenditures, Congress in 1983 completely revised the scheme for reimbursing Medicare hospitals. See Social Security Amendments of 1983, Pub.L. No. 98-21, Sec. 601, 97 Stat. 65, 149 ("1983 Amendments"). The new regime, known as the Prospective Payment System ("PPS"), relies on prospectively fixed rates for each category of treatment rendered. In contrast to hospital reimbursements under the reasonable-cost method, PPS rates do not vary in individual cases. Hospitals instead receive advance notice of the rates at which their services will be reimbursed, regardless of costs actually incurred. Congress designed this system to encourage health care providers to improve efficiency and reduce operating costs. Indeed, this link between prospectivity and efficiency lay at the heart of Congress' purpose when it created the PPS system:

The bill is intended to improve the medicare program's ability to act as a prudent purchaser of services, and to provide predictibility [sic ] regarding payment amounts for both the Government and hospitals. More important, it is intended to reform the financial incentives hospitals face, promoting efficiency in the provision of services by rewarding cost/effective hospital practices.

H.REP. No. 25, 98th Cong., 1st Sess. 1, 132 (1983), reprinted in 1983 U.S.C.C.A.N. 219, 351 ("House Report"); see also S.REP. No. 23, 98th Cong., 1st Sess. 1, 53 (1983), reprinted in 1983 U.S.C.C.A.N. 143, 193 ("Senate Report") ("[PPS amendments] are intended to create incentives for hospitals to operate in a more efficient manner, since hospitals would be allowed to keep payment amounts in excess of their costs and would be required to absorb any costs in excess of the DRG rates.").

Under PPS, Medicare authorities first construct a standard nationwide cost rate--the "federal rate"--based on the average operating costs of inpatient hospital services. See 49 Fed.Reg. 234, 251 (Jan. 3, 1984). They then assign a weight to each category of inpatient treatment, or "diagnosis-related group" ("DRG"). Finally, they calculate a "wage index" to adjust reimbursement rates to reflect regional variations in hospital wage costs. For each patient discharge, a hospital's final reimbursement is calculated by taking the federal rate, adjusting it for wage variations, and multiplying it by the weight assigned to the patient's DRG. See generally 42 U.S.C. Sec. 1395ww(d)(2) (1988).

The wage index reflects a requirement in the 1983 Amendments that the federal rate be adjusted to reflect geographic variations in labor costs. 2 See 42 U.S.C. Sec. 1395ww(d)(2)(H). The area wage indexes for each region are based on wage-cost data periodically submitted by Medicare hospitals across the country. The indexes are used at two points in the prospective payment rate calculation. First, regional wage indexes are used (along with other factors, such as inflation and hospital case-mix ratios) to modify and standardize the data used to establish the nationwide "federal rate." See 42 U.S.C. Sec. 1395ww(d)(2)(C)(ii). Second, once the federal rate has been set, the wage indexes are used to make regional adjustments to the labor-related portion of the federal rate. See 42 U.S.C. Sec. 1395ww(d)(2)(H). Because each wage index is used to develop the base national rate as well as to adjust that rate by region, a change in any single wage index can affect the reimbursement rate of each hospital in the country.

Recognizing that PPS dramatically changed the financing of the country's health-care delivery system, Congress provided a transition period in order "to minimize disruption that might otherwise occur because of sudden changes in reimbursement levels." Senate Report at 53, 1983 U.S.C.C.A.N. at 193. During the four-year transition period, an increasing proportion (25 percent each year) of the final reimbursement rate was based on the standardized "federal rate," while a decreasing proportion was based on the previous reasonable cost regime. 3 Thus, at the end of the transition period, reimbursement is based solely on the federal rate. 42 U.S.C. Sec. 1395ww(d)(1)(A)(iii). This appeal concerns the calculation of the federal rate component, based on the new PPS system, during the first transition year.

B. History of Proceedings. The error that led to this appeal occurred prior to the creation of the PPS system. A large Sacramento-area hospital (not a party to this appeal) supplied inaccurate 1981 wage data to the California state authorities. (The hospital provided accurate total wage and employee data, but submitted an incorrect "estimate" of the salary allocation between educational and hospital employees.) The state sent the data to the federal Bureau of Labor Statistics ("BLS"). The BLS provided the Secretary with the wage and employment data that was eventually used to construct the wage indexes published on September 1, 1983, applicable during the first (transition) year of PPS. As a result, the Sacramento wage index understated the actual labor costs faced by Sacramento hospitals relative to the national average in 1984.

The other Sacramento hospitals recognized the error upon publication of the index, which showed a drop in the Sacramento index compared to previous years. After investigation revealed the source of the incorrect data, the hospitals persuaded the errant provider to submit corrected wage data. The state and the BLS processed the new data and transmitted it to the Secretary, who recalculated the Sacramento wage index and issued a corrected index on August 10, 1984. 4 Nevertheless, because the wage index published in September 1983 remained in effect from January 1, 1984, through August 10, 1984, appellant-hospitals lost $730,600 in Medicare reimbursements that they otherwise would have received had the correct salary data been originally submitted.

When the hospitals sought to recover their losses after discovering the error, the Secretary's intermediaries refused to apply the recalculated wage index retroactively. The hospitals successfully appealed to the Provider Reimbursement Review Board (the "Board"). A Board majority ruled that this court's decision in Georgetown Univ. Hosp. v. Bowen, 862 F.2d 323 (D.C.Cir.1988) (Georgetown II ), combined with the need to correct errors to make disadvantaged parties whole, required the Secretary to apply wage index corrections retroactively.

Acting on behalf of the Secretary, the Health Care Financing Administration ("HCFA") reversed the Board. The HCFA Deputy Administrator concluded that the PPS regime depends on prospectivity, and that retroactive corrections would undermine the statutory purpose to base Medicare reimbursements on predetermined rates. The hospitals then sought review of the Deputy Administrator's decision in federal district court. 5 See 42 U.S.C. Sec. 1395oo(f)(1) (1988). On cross-motions for summary judgment, the district court upheld the HCFA Administrator's decision. The district court concluded that...

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